Securities Regulation and Litigation Lawyer & Attorney : OverRegd Blog : Lindquist & Vennum Law Firm, Minneapolis and Denver

In a definitive 8-0 opinion released earlier this week, the United States Supreme Court held that the Securities Litigation Uniform Standards Act of 1998 ("SLUSA") preempted a class-action lawsuit based upon Oklahoma state law that was initiated by former Merrill Lynch brokers against the company. The former brokers alleged that they were induced into "holding" certain securities long beyond the point they would have otherwise sold them by a fraudulent scheme Merrill Lynch implemented to artificially inflate stock prices.

The Supreme Court, in an opinion authored by Justice John Paul Stevens, recognized that "[t]he magnitude of the federal interest in protecting the integrity and efficient operation of the market for nationally trade securities cannot be overstated." Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Shadi Dabit, 04-1371, 547 U.S. ___ (2006) Download file

Plaintiffs had hoped to escape SLUSA preemption by limiting their class to "holders," as opposed to purchasers, of securities. However, the Supreme Court adopted a broad interpretation of the phrase "in connection with the purchase or sale" of securities as used in the SLUSA and thereby determined that the misconduct Plaintiffs complained of - fraudulent manipulation of stock prices - "unquestionably" fell within the confines of SLUSA preemption. The Supreme Court noted that a narrow reading of the SLUSA limited only to purchasers would "run contrary to SLUSA's stated purpose, viz., 'to prevent certain State private securities class action lawsuits alleging fraud from being used to frustrate the objectives of the 1995 [Reform] Act."

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The 2006 SIA Compliance and Legal Division Annual Seminar came to a close in Hollywood, Florida March 22. Once the tournament winners were announced, the general session was kicked off by seminar co-chair Linda Yarden's invitation to Seminar 2007 --"Survivor Phoenix." Next year's Annual Seminar begins on March 25, 2007, and will be held at the JW Marriott Resort & Spa in Phoenix, Arizona. Yarden joked that some of the "survivor" challenges will include: the race to book one of the 3 rooms at the main hotel; the networking challenge (passing out as many business cards as possible in a 3-day period); and finally, the CLE challenge (creative ways to get CLE credits for a round of golf or a one-hour hot stone massage). Seminar 2007 promises to be a great event.

Yarden's invitation was followed by the Enforcement Panel discussion which addressed current hot topics and enforcement priorities in the coming year.

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At the March 21, 2006 breakout session at the SIA Compliance and Litigation conference involving arbitration, Linda Fienberg, NASD, discussed two changes to NASD arbitration rules of special interest to the industry. The first rule -- "the explained award rule" -- will require arbitrators to provide explanation or rationale for their awards. This rule change stems from concerns raised by investor advocate groups, who wanted more clarity for investors regarding arbitration results. Feinberg indicated that the NASD received around 200 comment letters to the proposed Rule, mostly from industry representatives expressing concerns that the new Rule will result in higher costs and confusion as to what is expected of arbitrators. Fienberg said that while the NASD does plan to go ahead with the Rule, language in the final Rule will stress that explained Awards will not be of precedential value and are to be used only for the information of the parties. She also said that the NASD will provide examples as to the level of detail in Awards intended by the new Rule, stressing that Awards will not need to address each and every cause of action set forth in the Statement of Claim.

Feinberg also informed conference participants that the NASD will soon be filing a revised version of the non-party subpoena Rule. Under the revised Rule, only arbitrators - not attorneys - can issue subpoenas. Also, the revised Rule requires a party receiving subpoenaed records to notify the other parties within five days of receipt of documents. Attendees expressed concern with the proposed revisions, noting that subpoenaed records from brokerage firms are often the only records received of customers' trading histories. Industry members fear that requiring arbitrators to sign subpoenas will result in delay and, perhaps, an inability to obtain documents where inexperienced arbitrators do not understand the importance of brokerage account records. Fienberg said that the NASD will provide an opportunity to comment on the proposed changes to this Rule.

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Today's general session focused on issues that the SEC, NASD and NYSE are collaboratively addressing. Richard Ketchum, chief regulatory officer of the NYSE, stated that two major issues were improving coordination among the organizations and eliminating duplication in investigations and examinations by the SROs. Specifically, Ketchum indicated that the NYSE was working with the NASD to harmonize regulations and divide responsibility. The end result, should everything work according to plan, would be a consistent set of rules that according to Ketchum, would likely ensure greater member compliance.

Panel members reiterated the need for the SROs to eliminate duplication. In addition, panel member Lori Richards of the SEC, summarized ten areas that the SEC would be focusing on in the upcoming year:

1. sales practices;
2. supervision;
3. internal controls;
4. net capital and customer reserves;
5. trading;
6. fixed income;
7. money laundering;
8. information security; and
9. business continuity.

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Major Liabilites Break-out session

The Major Liabilities panel began with some eye-opening statistics: in the last year alone, regulatory agencies issued fines totaling more than four billion dollars; civil penalties totaled more than fourteen billion dollars; and, there were more than 100 criminal prosecutions of CEOs/CFOs.

Such financial penalties can be the nail in the coffin for a broker/dealer firm (think Arthur Andersen). The panel explored some possible defense theories that should be explored when a brokerage firm is faced with the threat of regulatory fines or civil penalties.

First, you might want to take a look at the SEC's January 2006 statement regarding financial penalties. That statement articulates three factors considered by the SEC in determining whether to impose a fine. Specifically, the panel noted a requirement that the broker/dealer receive a "direct benefit" as a result of the alleged wrongdoing. The panel theorized that it might be possible to argue that the individual wrongdoer(s) benefited and that no direct benefit inured to the broker/dealer firm.

A second theory focuses on the SEC's own admission that it is having a hard time distributing disgorged funds and penalty monies to victims. The panel mentioned that it could therefore be possible to argue that the system is not working, the money is not ending up in the hands of the victim, and as a result, imposing an excessive penalty fails to make the victim whole and should therefore be avoided.

Finally, the panel noted that many complaints state settlements that the defending broker/dealer firm may have entered into with the SEC. The panel noted that some courts in the 2nd Circuit have been willing to grant motions to strike regarding such settlements, reasoning that the settlements are not admissions and are prejudicial.

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As Martha Stewart found out recently, lying to investigators may land you in worse trouble than whatever it is they are investigating. NASD members should take note. Recent NASD Panel decisions confirm that lying to the NASD could have severe consequences.

For example, in Department of Enforcement v. D.M.W., Amended Hearing Panel Decision, NASD Office of Hearing Officers Disciplinary Proceeding, No. C06030035 (October 12, 2005), an NASD examiner, during a routine examination, requested a copy of a Management Agreement between the brokerage firm and its holding company. After several requests, a Management Agreement, dated August 1, 2002, was provided. But the examiner discovered an email dated November 5, 2002 appearing to reflect that D.M.W., an officer, director, and owner, was directing the firm's compliance officer to arrange to have the Management Agreement typed up, executed and backdated. At the hearing, D.M.V. testified that he intended the e-mail to be a joke to "jerk [the examiner's] chain." The Panel did not understand how the email could be interpreted as humorous or calculated to anger the examiner, and instead found it more likely that D.M.W. realized that the original Management Agreement had expired, and that a new Agreement should have been in place.

The Panel found that the email was an attempt to mislead the NASD staff, a violation of NASD Conduct Rule 2110. As a sanction, D.M.W. was barred from associating with any member firm in any capacity for misleading NASD staff in violation of Conduct Rule 2210.

By the way, the defense - "I was just joking" - is rarely successful. It reminds me of Don Howard, a Minnesota businessman who hired a man to murder his wife. After the murder, Howard was an immediate suspect because he had, unsuccessfully tried to hire several people to commit the murder. His defense - "I was just joking." He was quickly convicted.

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